Introduction

“Rich people plan for four generations. Poor people plan for Saturday night” –Gloria Steinem

Mark, what should I do with my 401(k) plan?”

I’m sitting in my office and standing before me is one of our company’s attorneys. This attorney is a friend and someone I know to be meticulous. He read and probably re-read everything the company published about our 401(k) plan. I assumed he, if anyone, would know exactly what to do. If he didn’t get it, how many others were asking the same question? I asked other employees and learned that many were confused and wanted more information.

A few years ago, as assistant treasurer for a large media company with sales exceeding $2 billion and several thousand employees, I was responsible for the day-to-day management of the company’s pension assets. Working closely with the Human Resources department, I did everything possible to make sure our employees received lots of information about the 401(k) plan. Every participant got two booklets and could request a videotape to learn more about the plan’s details and its investment offerings. But, there is only so much a company can do. Our primary business was not publishing investment books. I authored the publications and helped produce the video. When you write for a company, the armchair editors and lawyers review the copy. The Finance, Human Resources and Legal departments are involved. Each reviewer puts his or her spin on it and the result is a watered down version of the original. No corporate attorney wants the company to give investment advice. (“Mark, we could be sued if you say that!”) They edit out anything that appears to suggest a strategy.

If we had problems explaining the plan to the thousands of employees at my company, what do participants at other companies know? How do they deal with the company stock problem? Do they know how to diversify and smooth out the ups and downs of the stock market? What if the company publications they receive do not provide the information necessary to make sound decisions? I decided to write this book to explain what you must know to exploit your 401(k) plan to your best advantage.

Who Should Read This Book

I make the assumption that you are an employee who has limited investment experience. Many novice investors are put off by the vocabulary of investing. It’s like any other specialty. You must understand some basic vocabulary to succeed. Along the way, I will define and explain the terms and words you need to know. Read the boxes in the margin for explanations of the investment terms and other related financial information you need to know. Also many of the investment words found in this book are defined in the Glossary on page 207.

We’ll discuss investment advice and strategies. The focus is exclusively on what you need to know to understand your 401(k) plan. We’ll explore specific features that are common among all 401(k) plans—how and when to withdraw funds, how to take advantage of loans, how to avoid being taxed when changing jobs and retiring and how to measure the performance of your investment options.

This book is divided into three sections. Section I covers the mechanics of investing. Chapter 1 makes the case why you should save as much as you can possibly afford. We will introduce 10 rules that every 401(k) investor should know. Throughout this book we will refer to these 10 rules. They are simple and easy to understand. You’ll find that it takes a modest amount of discipline to follow them. Chapters 2 and 3 describe the two most important investment principals—compounding and risk.

In Section II, Chapters 4 and 5, we focus on the investment options that are available in many 401(k) plans.

The final section, Chapters 6 through 9, will cover rules and regulations that affect 401(k) plans. It’s your money, but it is difficult to withdraw and use. There are tax penalties and other expensive consequences that can happen when you don’t know about these regulations. Individual retirement accounts (IRAs), estate planning, college savings strategies and other personal investing topics are covered, but only as they relate to an employee with a 401(k) plan. We’ll also discuss measuring the performance of your investments and comparing your plan’s investment options with other mutual funds. We end the book with several withdrawal strategies for retirement.

When an author tries to simplify complex financial and legal information, and especially when he writes about investments and taxes, there are exceptions to the rule—which are noted throughout the book. To keep things simple, we’ll concentrate on investment ideas and tax situations that apply to most 401(k) participants. But, keep in mind that 401(k) plans are highly regulated. One of the reference texts I used to write this book has almost 1,000 pages devoted to regulations and laws pertaining to 401(k) plans. If you have a complicated financial situation, seek professional investment advice after you read this book. Appendix 2 helps you find and interview a financial planner.

Let me say that again. Because a short book can’t cover every situation described in the U.S. tax code, consult with experts to learn more about your particular situation.

For many employees, the 401(k) plan is their only corporate retirement benefit. After a long career, it will probably be the most valuable asset they own. As you approach retirement age, you should consult a tax advisor and financial planner to examine all the issues related to your investment situation and lifestyle. Obtain multiple opinions as you would from medical doctors before submitting to major surgery. The tax structure of the United States makes retirement planning complicated and you need more help than one book can provide. Seeking the advice of several experts is the prudent thing to do.

What you read here will provide a basic understanding of the typical 401(k) plan. Use this knowledge and ask questions. After reading the book, go back to the material your company gave you and re-read. It will make more sense. When in doubt, call your company’s benefits representative. He or she knows your plan intimately and can answer your questions.

I present objectively the information you need. Your circumstances will determine the correct investment allocation for you. The tables, figures and text will give you an idea of how much and in which funds you should invest. None of the information in this book should be interpreted as investment advice. It is presented to help you make your own decisions.

Nothing in this book will matter unless you begin saving in your company’s 401(k) plan. Every day that you put off saving costs you the potential to earn money in one of the country’s best tax-sheltered investments. If you haven’t done so already, sign up today! Save as much as you can afford. Every year, increase the amount you save. Reducing the net amount of your paycheck today may be painful, but you’ll build the security you need for the retirement years. Today’s markets are confusing and downright depressing. After the tremendous boom of the 1980s and 1990s when it was almost impossible not to make money, the market crashed. During 2000, 2001 and 2002, the aggregate U.S. stock market declined—a first for 401(k) investors. Not since the creation of 401(k) plans had the U.S. stock market declined two years in a row. Instead of making money, investors in U.S. stocks lost. Some lost big. Plan participants who were not well diversified saw a significant portion of their retirement nest eggs disappear. Can they recover before retirement?

Most can. Those more than 10 years from retirement should be able to recover if they continue to save and diversify their investments. Those with less than 10 years to go may have to save more or delay their retirement to make up for the losses from the last three years.

The investment climate is not all that 401(k) investors have to worry about. As 2002 began, the Enron scandal swept through the halls of Congress and into the courts. Enron was not an isolated case, as participants at WorldCom, Global Crossing and other companies learned. Many 401(k) investors found owning too much company stock is bad.

“Isn’t purchasing company stock the loyal thing to do?”

“Shouldn’t I support my company?”

The short answer is that owning too much company stock, even if the company is doing well, is a gamble. And, betting on your 401(k) is not the best way to save for retirement. In this book, we’ll explore strategies for diversifying the risk of owning too much company stock, even if your company won’t let you to sell the shares it contributes to your account.

The basic principle supporting the 10 rules and this book is that you have to take responsibility for your 401(k) plan investments. Indeed, the government and the company you work for assume you are in charge of all your personal finances. Everyday we are faced with decisions: should we save or should we purchase? There are so many things to buy and it is so easy to put that next purchase on a credit card. But every purchase means that you have missed an opportunity to save a little extra for the future. In the 401(k) plan, where the money you save is deducted from your paycheck before you can spend it, you have the opportunity to build a nest egg that will enable you to retire.

You Must Take Responsibility

Before the 1990s most large employers provided defined benefit pension plans. These plans delivered a monthly salary that continued throughout retirement. It was a reward for employees who completed 20 or 30 years of service. However, society and economics have changed. Few employees stay with one company for 10 years, let alone 20 or 30 years.

As a result, employees told companies that they wanted portable pension benefits. They wanted to take what they had earned toward retirement when they left one job and headed to another. In surveys, employees said to scrap the traditional benefit plan for something else. The result was the 401(k) plan. In this plan, you and often your employer, contribute to the plan. You take responsibility for how your savings are invested and when you leave the company for a new job, you keep whatever you have saved. If you are vested, a term we will explain later in this book, you will also get to keep the money your company contributed. Managing your money takes time and some effort. There are plenty of resources that you can use to help you. Many individuals like to do it themselves. That is becoming easier these days with the wealth of information and resources that are available on the Internet, in books and magazines and in computer software programs like Quicken and Microsoft’s Money.

Managing your finances does not differ from other tasks in life. We all pay taxes. If filling out the tax return is too difficult or too time consuming, you hire a specialist to help. With investing and financial planning, you can hire specialists to help. Like the tax specialist, financial planers do all the calculations and prepare a strategy and plan. Ultimately, you are responsible. You can either follow the plan or ignore it. But, if you don’t have a financial plan, you may find that living well in retirement is an impossible dream.

• How much should I set aside?
• What investment options are best for me?
• When should I change my investment options?
• How do I change investment options?
• How do I evaluate my investments’ performance?
• Why don’t they let me take out my money when I want it?
• How do I use this plan to save for retirement?
• Is there a catch? Why is the company doing this?
• How much income will I have when I retire and will that be enough?